FSL – OCBC

Dragged back into uncertainty

Vessel re-delivery. FSL Trust’s (FSLT) charterer Groda Shipping recently requested FSLT to take re-delivery of two of its product tankers Verona I and Nika I as Groda does not intend to continue to make full charter payments. To recap, both vessels are under a seven-year bareboat charter agreement fixed at US$20,700/day each until Nov 2014. For the month of May 2010, Groda has made full payment for only one of the two vessels. It has also told FSLT that from June 2010 onwards, full payments should not be expected for either vessel. The charter agreement was structured with a cash security deposit of US$3m/vessel (covering about five months of charter revenue) and an assignment of the long-term Contract of Affreightment (CoA) between Groda and OJSC Rosneft Oil Company, a Russian state-controlled energy company.

What happens to DPU? FSLT said it was exploring legal and commercial options, and that “best efforts will be made to ensure the uninterrupted operation of the vessels”. FSLT has the option to either continue the CoA with Rosneft (terms not disclosed) or re-deploy the two vessels elsewhere. The end result could potentially be at a lower rate than before. The two vessels contribute roughly 15% of total revenue. In our view, FSLT may be able to meet its DPU guidance for 2Q10 with cash reserves and the vessel deposits. However, DPU guidance for further quarters will depend on where the two vessels are employed and at what terms. Note that FSLT has to pay out US$32m (roughly 50% of cash earnings) in loan repayments every year during the covenant waiver period. The balance is utilized towards distributions.

Contagion key concern. Our key concern is what the redelivery means for the rest of FSLT’s product tanker portfolio (26% of total revenue including Groda). While Groda’s thought process is unknown, it seems to have found it more profitable to walk away from the deal (and the US$6m deposits) than to continue with the charter agreements. FSLT has always touted its focus on risk management and current events may be a good test of that focus. On a positive note, we understand from the manager that this development does not impact FSLT’s loans. Still, any reduction in revenue could affect FSLT’s plans to raise unsecured debt. We reduce our fair value estimate from S$0.59 to S$0.48 (which assumes a slight negative drag on cash earnings from the two vessels and increases our discount to FCFE value from 20% to 25%). Maintain HOLD.